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The selection of the insurance that you provide on your stock is really a determinant based on the amount of risk that you want to take.
Here’s something that nobody else is going to tell you. My position, when I take these positions – I actually did take a position in Starbucks. I took a position right around here. There was 3 or 4 days where the stock wasn’t really going anywhere, and it seemed to hit some sort of bottom here.
I looked at this high spike of volume, on this day in which Starbucks actually closed the day before, at $17.85. If you woke up the next day, it’s trading at 16. That was a pretty dramatic drop in the stock. The people who bought it on that day, the day before, for $17.75, and saw it trading the next day at $16, probably got pretty spooked, especially if they had a fairly large position.
I saw that very large volume of spike. Generally, the large volume spikes back here, here, and here, and eventually, when the stock started rallying a little bit and coming down, you can see that the volume on the sale side started drawing up dramatically. Each day that the stock continued to decline, there was a little bit more volume, but nothing even close to this volume here, or here, or here, in which days and days of high-selling volume were indicated by these red bars.
It seemed to have dissipated. A lot of the sellers probably got out at this point, and they weren’t too many sellers left. People who were holding the stock for a long term, or purchased on this day, were here to hold it, and weren’t really aggressive sellers, at that point.
Once that aggressive selling had started to decline, I felt it was a low-risk opportunity to start purchasing some shares. Even though volume on the upside did not really materialize, every time the stock declined slightly – especially on these two days here – declining volume, these two red bars here, were extremely low.
These two days of very low volume on the day in which the stock declined indicated to me that the selling had dried up. Remember, I had been watching this stock for quite some time. In fact, I started watching it back in here, back in July and August of last year.
I began to look at the stock when it was really volatile here, but there was still a good amount of selling going on. I took a look, in particular, at this day here. I noticed that the selling was quite large. What I was looking for was a time in which the stock would come back down to those levels on some selling pressure, and price pressure, on lower and lower volume.
There were some days here in which volume was extremely low. However, there were some days in which there was extremely high volumes of selling. I decided to wait on the stock. I also didn’t see a very good pickup compared to the amount that was being sold, on the days in which it was increasing.
In fact, during this increase in price here, and this decrease here, there was actually selling pressure that was higher than the day before, where there was buying pressure. As it declined here, the selling continued to increase. You can see that volume increased at a time when the stock was decreasing. That’s generally not a good sign.
I continued to watch the stock. As the stock continued to trade, it traded lower and lower, on increasing volume. That is generally not a good sign. Volume continued to increase as the stock declined. Once again, if I took a good look at the trend here, it would indicate that selling has increased each time the stock decreased. That only indicated, to me, that additional selling pressure would be forthcoming, and additional pressure on the downside would be coming.
Until it got to the point where it looked like – even though we had one large day here of downward pressure, and quite a large spike in volume, during this time, there didn’t seem to be a lot of pressure on the stock, as it declined in price. It wasn’t until this capitulation volume here that occurred, which I always look for. I always look for this. This is really a climactic selling point in the stock, because it’s actually larger than any of the previous selling days.
You can go back all the way to August of 2006, when we had this large decline in the stock. It was even larger than that. A lot of the people who were hoping that the stock would advance here and here, and go back up to the point in which they bought the stock, so they could sell it and remain whole – that never happened. Once they saw the stock drop from this level, and gap lower by a couple of bucks, they realized that, “Hey, there’s no more hope left for Starbucks, so I’m getting out.”
That was the huge amount of volume here that I was looking for. After that happens, then I start to look for a spot in which I can take a position. I actually purchased a stock right here. Shortly after that, the stock started trading up.
Did I buy protection? Yes, I did. My point of this analysis is to give you an idea of how to evaluate not only a potential timing point of entering a stock position, but also giving you an idea of how I would have traded this.
Generally, what I like to do is let the stock prove itself. In other words, I would have purchased a much better position. If I was to purchase Starbucks now, I would have purchased the higher insurance policy, that limited my downside risk to $430.
If the stock proves itself, and it does increase in price – yes, my upside potential is somewhat limited. However, I still make a profit, don’t I? My downside risk is limited to just $430. That’s an acceptable risk, based on an $18,000 stock purchase.
What I’m looking for here is for the stock to prove that it will continue to increase in price. If I looked at the chart, and I said, “Okay, I think my purchase, at this point, is probably a good idea because we do have a nice increase in the shares of the stock, from a low of about $15.50, all the way up to $18.50. Since there’s a little pull-back here, this might be a good opportunity to enter into the stock.”
I’m not thinking that, at this point, because the volume on the up-day is pretty low. You have to have a couple of good up-days. You have higher volume on the up-days than you do on the selling days, with the red bars. It may be an attractive opportunity. I’m not suggesting that you go out and buy Starbucks stocks. I’m simply giving you an example of what I would be thinking as I analyze the stock, and analyze my risk and reward in this position.
What I want to do is be able to purchase 1000 shares of Starbucks stock, pay the $1400 in insurance to hold the stock, limiting my downside risk to just $430, until July. Remember, this option – the 10 contracts that we’re going to buy as protection for this position – will expire in July.
What happens at that time? We’ll talk about that.